As deflation becomes an ever more mushrooming concern of capital markets worldwide, commodity demand and, consequently, returns remain highly susceptible to intensifying downside volatility in prices of agricultural produce, energy and materials. Downward revisions to global and German economic activity, decelerating inflation in the United Kingdom (UK) and Germany and stagnating price pressures in the Eurozone are not only complicating the efforts of Berlin, London and other European capitals to abide by budget-tightening programs.
Rather, they are encouraging regimes on the continent to shift the focus of fiscal policymaking from restraint to expansion in order to prevent disinflation from transitioning to declining living costs and forestall the attendant long-term contraction in private consumption and capital formation that inexorably ensues from the self-fulfilling psychological expectation of ever decreasing prices.
The specter of deflation is haunting virtually every asset market, convulsing the mood among commodity and equity investors alike into despair. S&P’s Global BMI index fell only 1.2 percent year-to-date, but has plunged 8.4 percent in just the last forty-five days, which coincides with the European Central Bank’s (ECB) decision to embark on aggressive credit relaxation as well as the Federal Reserve’s (Fed) and Bank of England’s (BoE) uncertainty about when to normalize their policy rates at the short end of the US Treasury and UK gilt curves, respectively.
Whatever remaining apprehensiveness investors may have had regarding a rebound in inflation has dissipated rapidly and systematically. Symptomatic of waning fears about reviving price pressures, inflation swap rates and breakeven cost of living rates on inflation-linked sovereign issuance across the developed world, except Japan, have been and should remain on a steadily descending path – discouraging the Fed and BoE from raising credit costs anytime soon and encouraging the ECB to intensify its quantitative monetary loosening to fend off what would be the currency union’s third recession in six years.
Trends in agriculture and livestock returns will continue to move in different directions until competitive market dynamics result in a realignment of short-term productive capacity with strengthening demand for the former to erode the current surplus of crops. Although Global Markets Intelligence sees no immediate reason for livestock prices and demand to lose their upside momentum in the months ahead, we caution investors to maintain only a modest exposure since prices appear to be at or near a peak. As for farm produce, excess crop supplies are expected to persist and eventually dwindle ever so slowly, which should proceed to depress prices and deter investor demand for the immediate future.
Prices of industrial and precious metals will proceed to go their separate ways now that investors’ disposition in relation to risk has turned decidedly antipathetic. On the one hand, global industrial demand for extracted ores and other raw materials is for the most part cyclical, meaning more is produced to meet rising demand during an economic upturn and less is mined in the face of declining demand in periods of receding economic growth. So, in light of mounting anticipations of slower economic activity and declining manufacturing output throughout Western Europe, further industrial price decreases are foreseen, worsening the performance prospects for the extractives and justifying little, if any, exposure to them in investment portfolios.
Precious metals, on the other hand, merit a modest exposure – especially, in times of resurgent risk aversion amid heightened event risk. Either a diversified holding of palladium, platinum, silver and gold or a single allocation to the yellow metal appears desirable in view of the ongoing political crises in Ukraine and the Middle East in addition to growing fears of Ebola infections spreading westward that have engendered considerable risk aversion among investors as evident in the upsurge in the VIX and other such gauges.
The energy sector of the commodities market will remain subject to limited downside price pressures well into 2015. A massive glut in the supply of petroleum is anticipated to stay in effect until macroeconomic growth resumes an upward course, engendering the requisite industrial demand worldwide for relieving the present oversupply of oil stemming from additional extraction by shale producers in the US. With oil prices having plumbed an $80 per barrel nadir in reaction to not only US fracking, but also the Organization of Petroleum Exporting Countries’ (chiefly, Saudi Arabia’s) reluctance to reduce production, the cost of petroleum and its derivative products (like gasoline) are likely to decline further – rendering investment exposures to undesirable for the time being. The $70 to $75 breakeven price range for extracting oil from shale profitably should limit the downside to oil prices, which – if reached – would probably aid in reducing the supply glut. Yet, natural gas could be a worthwhile holding this winter in the event supply shortages were to emerge as a result of Russia’s threats to unilaterally sever supplies to Ukraine and Europe.
Global Markets Intelligence (GMI) emphasizes anew that risk-eager investors, who prefer concentrated exposures to individual commodities, should evaluate each one on its own merit – concentrating on the underlying supply and demand fundamentals as well as possible event risks driving its price action. However, for risk-neutral or –averse investors seeking diversification, passive (index-linked) instruments would appear most appropriate.